What is forex ? What Am I Doing When I Trade Forex?
Forex is a commonly used abbreviation for “foreign exchange,” and it is typically used to describe trading in the foreign exchange market by investors and speculators.
For example, imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.
This is similar to stock trading. A stock trader will buy a stock if they think its price will rise in the future and sell a stock if they think its price will fall in the future. Similarly, a forex trader will buy a currency pair if they expect its exchange rate will rise in the future and sell a currency pair if they expect its exchange rate will fall in the future.
Forex has exploded in popularity over the last 40 years as more and more people have discovered currency trading. The currency exchange market, also known as Forex, is one of the fastest growing markets today. It is the largest market in the world. The average day will see over 2.5 trillion dollars exchange hands! Throughout the year, world currencies fluctuate in value. Some currencies grow in value, while other currencies lose value. Investors make money by exchanging two currencies that are fluctuating in value.
There are many participants in the currency markets. Governments exchange currencies. International businesses exchange money every day. Other players include private investors, hedge funds, and banks.
Since the major world currencies are centered in different locations around the world, the Forex market is open 24 hours a day. Markets close on the weekends, but the markets are open the rest of the week.
Every participant works with their own currency first. The British exchange pounds, and Americans trade dollars. All currencies, known as goods in Forex, are traded in pairs. There are eight major currencies in the market, and this will be discussed in greater detail in the next section.
Participants make money in Forex trading by buying low and selling high. Successful traders learn how to recognize market indicators, trends, and other financial data. Participants make money quickly through leverage. Leverage is simply the ratio of investment to financial value. Leverage allows the participants to make or lose money fast!
Forex is somewhat similar to the stock market, but there are still many differences. In the stock market, physical shares are purchased. In the Forex markets, you only exchange agreements to trade shares.
In order to make real money in Forex, it is important to understand the history and general principles of the market. The most successful investors understand the markets inside and out. They have a respect for the history of the market, and they use this history to make better decisions in the future.
What Is An Exchange Rate?
The foreign exchange market is a global decentralized marketplace that determines the relative values of different currencies. Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value, and it’s also rare that any two currencies will maintain the same relative value for more than a short period of time. In forex, the exchange rate between two currencies constantly changes.
For example, on January 3, 2011, one euro was worth about $1.33. By May 3, 2011, one euro was worth about $1.48. The euro increased in value by about 10% relative to the U.S. dollar during this time.
Why Do Exchange Rates Change?
Currencies trade on an open market, just like stocks, bonds, computers, cars, and many other goods and services. A currency’s value fluctuates as its supply and demand fluctuates, just like anything else.
- An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
- A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
This also means that there really is no such thing as a “bear market,” in the traditional sense. You can make (or lose) money when the market is trending up and down.